Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/125084
Authors: 
Hommes, Cars
Massaro, Domenico
Weber, Matthias
Year of Publication: 
2015
Series/Report no.: 
Tinbergen Institute Discussion Paper 15-087/II
Abstract: 
Expectations play a crucial role in modern macroeconomic models. We replace the common assumption of rational expectations in a New Keynesian framework by the assumption that expectations are formed according to a heuristics switching model that has performed well in earlier work. We show how the economy behaves under these assumptions with a special focus on inflation volatility. Contrary to comparable models based on full rationality, the behavioral model predicts that inflation volatility can be lowered if the central bank reacts to the output gap in addition to inflation. We test the opposing theoretical predictions with a learning to forecast experiment. The experimental results support the behavioral model and the claim that reacting to the output gap in addition to inflation can indeed lower inflation volatility.
Subjects: 
Experimental Macroeconomics
Heterogeneous Expectations
Learning to forecast Experiment
Trade-off Inflation and Output Gap
JEL: 
C90
E03
E52
D84
Document Type: 
Working Paper

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